Is the pension fund consulting business afflicted by conflicts of interest even more so than the analyst-investment banker incestuous relationship? The Securities and Exchange Commission (SEC) is looking for an answer to this disturbing question: that is why last December it opened a “fact-finding mission”, a broad examination of the industry.
It sent a letter to many US-based investment-advisory firms – like Mercer, Frank Russell, Segal Advisors, Wattson Wyatt, Wilshire Associates - seeking a range on information about their activities between January 1, 2002 and November 30, 2003. It is currently reviewing the information received.
Nevertheless just the news of the inquiry is stirring debate and changes in the US pension fund world.
“Allegations of pay-to-play are very serious and really triggered our interest,” explains Lori A Richards, director of the SEC’s office of compliance inspections and examinations. ‘Pay-to-play’ are alleged schemes that involve a money management firm paying a consultant through various hidden means, in return for a recommendation to a pension fund.
Critics of the pension consulting industry have long complained about such problems. According to Don Trone, president of the Foundation for Fiduciary Studies, confirmed pay-to-play schemes can supply up to 25% of consulting firms’ revenues.
But implicit schemes are even more widespread and lucrative. They come in four types of ‘services’ sold by consultants to money managers: conferences with the consultant’s clients; performance measurement reports; performance measurement software; training, marketing and sales consulting. An oft-cited example are annual conferences held by top consultants for plan sponsors and money managers: they can cost more than $50,000 (E41,000) per person to attend for the money managers, but they are often free for the plan sponsors; some are held in locations like Pebble Beach, California. Critics say that money managers who pay for the privilege to be there are more likely to get recommended by consultants to pension officials. Investment performance reports can also easily cost $40,000 and more per asset class, adds Trone, who used to work for Callan, one of the leading US consulting firms-–its clients oversee $800bn in pension assets.
A recent article on consultants ‘A bribe by any other name’ in US business monthly Forbes, has drawn an angry reaction from Callan, a consulting firm. The fees for conferences Forbes reported of $51,000 per person from a manager, could be for a whole organisation’s annual membership of the Callan Institute, which includes access to research, data and workshops, as well as half a dozen conferences. “No one has ever pointed to any specific instance – even once – where Callan made a consulting decision based upon who is or is not a member of the institute.”
Interesting to note is that 80% of the public retirement systems use pension consultants, compared with only 41% for corporate pension funds and 25% for foundation endowments. But the results are not flattering for the public pension funds. According to the Foundation for Fiduciary Studies, they averaged annual returns of only 8.1% in the decade through 2002, half a point less than corporate retirement plans and a full point less than foundation plans. So why do public pension plans so often use consultants? Because they don’t want to take responsibility for picking the investment managers in order to protect their careers, explains an insider: the logical solution is to hire an ‘expert’ and have him be the ‘fall guy’, the one ready to take the blame when things don’t work out.
The problem is how consultants play the game in this huge market. Not only are there the luxury conferences, but there is also the potential for conflicts of interest between the advising business and the securities trading, when a firm has affiliated broker-dealers (as it happens with Frank Russell and Mercer). If a pension fund routes its trades to these brokers, will the fees be fair or will ‘soft dollars’ be paid?
The first consulting firm that has changed its organisation in light of the SEC examination is Wilshire. In a statement last February, its board “determined that in order to strengthen the ethical walls and eliminate the possible appearance of conflicts of interest, it was necessary to separate the funds management and consulting divisions and have them headed by different executives.”
Ironically, Wilshire’s move has not been praised by its clients, who appear to be more concerned about the shakeup in senior management than about conflicts of interest.

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